Bitcoin is of interest to law enforcement, tax authorities, and legal
regulators, all of which are trying to understand how it fits into
existing frameworks. The legality of your bitcoin activities will depend
on who you are and what you are doing with it.
Bitcoin has proven to be a contentious issue for regulators and law enforcers, both of which have targeted the virtual currency
in an attempt to control its use. We are still early on in the game,
and many legal authorities are still struggling to understand the
cryptocurrency, let alone make laws around it. Amid all this
uncertainty, one question stands out:
is bitcoin legal?
The
answer is yes, depending on what you’re doing with it. Read on for our
guide to the complex legal landscape surrounding bitcoin. Most of the
discussion concerns the US, where many of the legal dramas are currently
playing out.
What are the concerns about bitcoin?
Government
agencies are increasingly worried about the implications of bitcoin, as
it has the ability to be used anonymously, and is therefore a potential
instrument for money laundering. In particular, law enforcers seem to
be concerned about the decentralized nature of the currency.
As early as April 2012, the FBI published a document
highlighting its fears around bitcoin specifically, drawing a
distinction between it and centralized digital currencies such as eGold
and WebMoney. It voiced concerns that while US-based exchanges are
regulated, offshore services may not be, and could be a haven for
criminals to use bitcoin for illicit activities without being traced.
Bitcoin
has been commonly used as a form of currency when trading on Silk Road,
an anonymous marketplace that can only be accessed over the TOR
anonymous browsing network. Silk Road is commonly used to sell goods
that are legal in many countries, including narcotics. This prompted US
Senator Charles Schumer to call for the site to be shut down, explicitly linking it to bitcoin, which he called a “surrogate currency”. And the US Drug Enforcement Administration seized bitcoins from a US resident for purchasing a controlled substance in June 2013.
Who regulates it?
Regulators
will vary on a per-country basis, but you can expect to see national
financial regulators interested in bitcoin and other virtual currencies,
potentially along with regional regulators at a sub-country level.
FinCEN
In the US, the Financial Crimes Enforcement Network (FinCEN),
which is an agency within the US Treasury Department, took the
initiative. It published guidelines about the use of virtual currencies.
FinCEN’s March 18, 2013 guidance
defined the circumstances under which virtual currency users could be
categorized as money services businesses (also commonly known as money
transmitting business or MTBs). MTBs must enforce Anti-Money Laundering
(AML) and Know Your Client (KYC) measures, identifying the people that
they’re doing business with.
CFTC
The US Commodity Futures Trading Commission (CTFC), which looks after financial derivatives, hasn’t announced regulation yet, but has made it clear that it could if it wanted to.
SEC
The
US Securities and Exchange Commission (SEC) hasn’t issued solid
regulations on virtual currencies, but its Office of Investor Education
and Advocacy published an investor alert to warn people about fraudulent investment schemes involving bitcoin. In particular, it warned of Ponzi schemes, after charging
Texas resident Trendon T Shavers, aka ‘pirateat40’, founder and
operator of Bitcoin Savings and Trust, with allegedly raising 700,000
bitcoins by promising investors up to 7% weekly interest.
Legislative branch
The
SEC case has forced the legislative branch of government to consider
bitcoin’s legal status. Shavers had claimed that he could not be
prosecuted for securities fraud, as bitcoin wasn’t money. However, Judge
Amos Mazzant issued a memorandum arguing that bitcoin can be used as money.
In August 2013, the US Senate wrote to several law enforcement agencies, inquiring about the threats and risks relating to virtual currency. The letters included this one
to the Department Of Homeland Security, fretting about the lack of a
paper trail for regulators and enforcement agencies to follow for
virtual currency transactions. It requested policies and guidance
related to the treatment of virtual currencies, and information about
any ongoing strategic efforts in the area.
US states
Each
US state has their own financial regulators and laws, and each
approaches bitcoin differently. California and New York have been
particularly aggressive in their pursuit of bitcoin-related
organizations, for example, while others, such as New Mexico, South
Carolina, and Montana, don’t regulate money transmitting businesses.
There is a list of state approaches to money transmitter laws here.
In May 2013, California’s state financial regulator issued a letter
to the Bitcoin Foundation, a nonprofit organization designed to promote
bitcoin, warning it that it may be a money transmission business, and
threatening people there with potential fines and jail time.
Then, in August 2013, the New York Department of Financial Services issued subpoenas to
22 bitcoin-related companies, although these letters were more
conciliatory, asking for a dialogue to develop appropriate regulatory
guidelines for the digital currency industry.
Private sector companies (banks)
Several banks have stopped accounts owned by people operating bitcoin exchanges. In at least one case, this was because the bank was unhappy that the company involved did not have a money transmitting business (MTB) account.
What this means to you
The
legality of bitcoin depends on who you are, and what you’re doing with
it. There are three main categories of bitcoin stakeholder. Someone may
fall under more than one of these categories, and each category has its
own legal considerations.
Users
These are individuals that
obtain bitcoins, and either hoard them or spend them. Under the FinCEN
guidance, users who simply exchange bitcoins for goods and services are
using it legally.
FinCEN: “A person that creates units of this
convertible virtual currency and uses it to purchase real or virtual
goods and services is a user of the convertible virtual currency and not
subject to regulation as a money transmitter.”
Miners
According to the FinCEN guidance, people creating bitcoins and exchanging them for fiat currency are not safe.
FinCEN:
“By contrast, a person that creates units of convertible virtual
currency and sells those units to another person for real currency or
its equivalent is engaged in transmission to another location and is a
money transmitter.”
Miners seem to fall into this category, which
could theoretically make them liable for MTB classification. This is a
bone of contention for bitcoin miners, who have asked for clarification. This issue has not to our knowledge been tested in court.
Exchanges
Exchanges are defined as MTBs.
FinCEN:
“In addition, a person is an exchanger and a money transmitter if the
person accepts such de-centralized convertible virtual currency from one
person and transmits it to another person as part of the acceptance and
transfer of currency, funds, or other value that substitutes for
currency.”
Taxation
In 2009, the US Internal Revenue Service (IRS) posted information about the tax applications of using virtual currencies inside virtual economies,
arguing that taxpayers can receive income from a virtual economy and
could be required to report it as taxable income. However, it based this
largely on guidance related to bartering, gambling, business, and hobby
income.
However, the IRS has not yet posted guidance on ‘open
flow’ virtual currencies that can be used outside of virtual economies.
In a 27-page report [PDF] published in May 2013, the US General Accounting Office (GAO) called for more guidance from the IRS on this issue.
The
IRS responded that its guidance could now be taken to cover virtual
currencies as used outside of virtual economies. It added that it was
also looking at the potential tax compliance risks posed by anonymous
electronic payment systems, and was working with other federal agencies
on the topic.
In June 2013, the director of an IRS unit that investigates cyber threats also told the Financial Times
that the use of “cyber-based currency and payment systems” to hide
unreported income from the IRS is a threat that it was “vigorously
responding to”. In short, don’t expect to evade taxes by earning
bitcoins instead of fiat currency.
What is the industry doing?
The industry has responded to growing regulator concerns in several ways.
- Several companies created a committee to form a self-regulatory body called DATA, designed to encourage open conversation with regulators.
- The Bitcoin Foundation formed committees to offer legal guidance, steer policy, and liaise with regulators.
- Exchanges
have been attempting to secure MTB licenses at the state and federal
levels, and some have avoided doing business with US customers until
this is resolved.
